The cutting edge of benefit cost control

The cutting edge of benefit cost control – related article: Maytag: Solutions Found in Consolidation, Redesign and Automation

Fay Hansen

Benefit costs are ripping a hole in the bottom line, and many employers don’t see a way out. But some executives are finding that they can cut, cost-share, and renegotiate their way to significant savings.

Robert B. Catell, chairman and CEO of KeySpan Corporation, the largest distributor of natural gas in the Northeast, closed out 2002 with an announcement that no CEO wants to make: Rising expenses from employee benefits will shave 20 to 30 cents off earnings of S2.86 per share that had been expected for 2003. Something has to be done.

With 12,000 mostly long-tenured employees spread over several states and organized into different unions, the Brooklyn-based company is short on cost-cutting options. The CEO’S aim traditionally has been to keep cost increases in line with the general rate of inflation. “In the past, this was a reasonable goal,” says Elaine Weinstein, senior vice president of human resources. “However, given the escalating cost of health care, this is now a very aggressive target.” In 2002, KeySpan’s benefit costs rose 13 percent. For 2003, “our stretch goal is to keep the increase at 7 to 10 percent. If I achieve 7 percent, I’ll be a hero.”

Weinstein faces the same deadly combination of rising pension contributions and runaway health-benefit costs that now preoccupies human resources executives at other top companies. Employers absorbed health-benefit cost increases averaging 15 to 20 percent in 2002 and budgeted for increases averaging 15 percent this year. Many must also ante up huge pension contributions forced by poor investment returns. “Equities have tanked, so our cash contribution is up dramatically,” she says. “Our assumption is that equity markets will remain flat for 2003, and all HR planning is based on that assumption.” Watson Wyatt Worldwide reports that 30 percent of companies were forced to make cash contributions to their pension plans in 2002; 65 percent will have to do so this year.

With little or no revenue growth to cover these additional expenses, rising benefit costs are ripping a hole in the bottom line. Human resources executives are on notice from top management to contain or cut costs–now. Depending on the degree of economic pressure, the composition of the workforce, and conditions in the local labor market, executives are pursuing different objectives and strategies. Some are cutting benefits and slicing salary budgets to offset rising costs. Others are turning to aggressive vendor management to achieve cost reductions without cuts or greater employee cost-sharing. In all cases, successful cost control hinges on well-defined objectives, careful workforce analysis, and a holistic approach to the problem.

Long-term, incremental change

Given KeySpan’s workforce composition, Weinstein’s goal of simply holding costs constant is daunting. Hemmed in by heavy contractual obligations and extremely low employee turnover, she focuses on long-term, incremental changes in both retirement and health-care benefits, and begins laying the groundwork before cost increases hit crisis proportions. “HR is extremely tough these days,” she says, “and controlling costs is difficult, but my job is easier because my CEO and my company are very employee-sensitive, and I have tremendous access to and dialogue with top management.’

Weinstein has the information and leverage she needs to make major changes because she sits on the company’s executive committee. “When I came into the company seven years ago and saw that there was no cash-balance plan, for example, I said to the committee, ‘Let me show you some best practices and what we can do for new hires.’ I drove the pension issue.” She launched a cash-balance plan for managers in 2000 and for some unions in 2001 and 2002.

Of all the issues related to benefit cost increases at major companies, pension funding is now the most expensive and the most intractable. KeySpan’s new cash-balance plan will cut the company’s annual pension costs by 30 percent for each new hire, but moving existing employees into the new plan is a slow process. “Two-thirds of our employees are unionized, so we attempt to negotiate the cash-balance plan as various contracts come up, but our defined-benefit plan is still very dominant,” Weinstein says. Cash-balance plans help control costs because final retirement benefits are not predetermined, as is the case in traditional defined-benefit plans. Benefits are based solely on the amount that accumulates in each employee’s account from annual employer contributions, which are usually a percentage of salary, plus earned interest.

With a viable solution in place in the area of pensions, she is focusing on health-benefit costs. “We negotiate very aggressively with our health-benefit carriers, and because of the pressures they face, we have been able to extract some concessions,” she says. The company is also inching up employee contributions for both union and nonunion workers. Management employees now contribute 23 percent of their premiums, up from 20 percent in 2002. KeySpan also adopted a three-tier design for its prescription program and eliminated multiple vendors to reduce administrative costs. A new mandatory mail-order program for recurring prescriptions has saved the company $1 million.

KeySpan’s limited ability to find sufficient immediate savings in benefit costs has forced it to take a holistic, total-compensation approach to cost control. In February 2003, KeySpan froze all merit increases for 12 months for managerial employees and for 24 months for executives. “This has been traumatic for our company’ Weinstein says. “The decision came from the top, and the impact starts at the top.”

For some cost issues, top management approaches Weinstein with questions, and she does the research and provides the information that the executive committee needs. “Then we discuss it and vote on it,” she says. In other cases, she initiates proposals for change. “There’s a lot of verbal noise about HR being a business partner, but you must bring to the table a knowledge of the business or you can’t possibly play a partnership role. If you can’t do that, then all the talk is just garbage. I understand the business, which is why I can take an aggressive approach to defining the problems and proposing solutions.”

Deep cuts without layoffs

Human resources also took an aggressive approach at CUNA Mutual Group, which provides financial services to credit unions and their members. Vice president of compensation Teri Edman spent the better part of three months handling 80 percent of the analysis, design, and approval process to cut $23.2 million from the company’s compensation and benefit costs for 2003. Like Weinstein, Edman operates in relatively tight spaces. Half of the company’s 5,000 employees are at corporate headquarters in Madison, Wisconsin, two-thirds of them unionized. The company wanted cost improvements without significant staff reductions.

“Both our revenues and expenses have been dramatically affected by the economy, and the majority of our controllable expenses are staff-driven,” Edman says. Human resources developed proposals for the changes; top management discussed them over a two-month period and gave final approval. Edman took a total-compensation approach. A substantial $15 million in savings will come from the elimination of the 2003 salary-increase budget, with no merit or across-the board increases for any employee group. The company also eliminated the annual holiday gift–$300 per employee–for both 2002 and 2003.

An additional $8.2 million in savings will come from health-care and vacation-benefit changes based on careful market analysis. “We targeted benefit plans in which we were over market and obtained feedback from our employees about what types of changes were most acceptable to them,” Edman says. To minimize the impact on recruitment and retendon, “we modeled the cost savings of various alternatives and compared the proposed changes to market-competitive data and to our own experience in recruiting.”

Although many employers have eliminated HMO plans, which now register the highest cost increases of all plan types, CUNA Mutual kept its HMO but added co-pays for office visits. It also joined the significant employer shift to a three-tier prescription plan, increased drug co-pays, and obtained new networks for its medical-indemnity and dental plans. Edman anticipates saving $3 million from the combined health-benefit changes.

The company will save $5.2 million from a new vacation-buyback program. “We had a very generous carryover provision that allowed employees to accumulate up to two years’ worth of vacation earnings,” Edman says. “This unused vacation had grown to an expense liability of $24 million. We needed to decrease this expense, but because of our workload, we could not afford to have employees taking larger than normal amounts of vacation.” Under the new program, employees can elect to give up earning new vacation for 2003, and in exchange can sell for cash an equal number of days from their carryover. They also commit to using an equal number of days from their carryover for time off this year.

CUNA Mutual carefully communicated the reasons for the changes to employees. “We illustrated the negative trend in our revenues and expenses over the past few years and our projections for 2003 and beyond,” Edman says. “We explained the environmental economic factors that are beyond our control, and demonstrated our need to take action now to protect our future.” The company has not experienced higher turnover or a drop in benefit enrollments because of the cost-reduction measures, but Edman continues to monitor employee reaction. “We stay in touch with our employees through various feedback methods, including electronic communications, departmental meetings, staff forums with the CEO, and culture surveys.”

KeySpan provides comprehensive information to its employees about its benefit changes. “Our communication strategy is a cascading model,” Weinstein says. “After the executive committee approves the changes, we first present them to the officers, who then present the information and explanations to their employee groups? For the presentations, KeySpan uses a program called “Straight Talk,” which scripts the communications delivered by officers. The scripts for benefit changes are “a way to assist employees in managing their expectations about employee contribution increases and to explain why changes are necessary;’ she says. An employee-benefits newsletter, the company’s intranet, and open-enrollment packages also explain benefit changes in detail. “By the time employees receive the open-enrollment packages, they have already heard the message three or four times?

Working in relatively restricted environments and with specific mandates to control costs without jeopardizing employee relations, Weinstein and Edman have found substantial long-term savings. KeySpan and CUNA Mutual are among a growing number of employers that are adjusting total compensation to address the crisis in benefit costs. Benefit cost increases have outpaced wage and salary cost increases for the past three years and will continue to do so for the foreseeable future. Almost one-fourth of employers have decreased or are considering decreasing 2003 salary-increase budgets to offset rising health-care and pension costs, according to a survey by Mercer Human Resource Consulting. The holistic approach to cost-cutting at KeySpan and CUNA Mutual erases the line commonly drawn between salary and benefits budgets and allows executives full range of movement to tackle rising costs.

Most companies have already picked all the low-hanging fruit among benefit cost-cutting options without achieving sufficient results. Many continue to approach cost-cutting on an ad hoc basis, without careful analysis of which cuts will yield the greatest long-term savings with the lowest impact on business objectives. Executives at companies with focused strategies can push their costs into more acceptable territory, secure support from top management, and minimize the impact on employees.

RELATED ARTICLE: Maytag: Solutions Found in Consolidation, Redesign, and Automation

Maytag Corporation executive vice president and CFO Steven H. Wood told analysts in November 2002 that the company had pulled $135 million out of cash flow for pension contributions in 2002 and would pay an additional $160 million in pension contributions plus higher retiree medical expenses in 2003. The Newton, low a, appliance manufacturer also faced increased health-benefit costs for its 21,000 employees worldwide. “There are union health plans that we cannot change, but we have reduced the number of plan offerings for salaried employees,” says Tracy Sears, director of benefits programs. The company consolidated offerings in 2002 and estimates savings of $2 million for 2003. “Before we consolidated, we had 81 plans across the organization supplied by 50 different vendors,” she says. “Now we’re dealing with 12 vendors, so we will be able to reduce costs through economies of scale. Also, we’re no longer offering an HMO option, so employees do not have first-dollar coverage.

The company is also addressing pension costs. Effective July 1,2003, new hires will be offered a cash-balance plan and will not be eligible for retiree medical coverage. Current employees will be offered a choice between their current retirement plan and a cash-balance plan, and must meet new eligibility criteria for retiree medical coverage.

Maytag will shave almost $1 million off 2003 benefit costs with a new automated enrollment system from ProAct Technologies that went live in October 2002. Before automation, Maytag administered enrollment with staff at 12 regional offices. Five regional benefits administrators now perform the same functions. “Using an online system also frees up time for the regional benefits staff to communicate to each location the benefit costs for the site and a comparison to a company norm,” Sears says. ‘Top management was behind the changes to support the head-count reduction and also felt there was a need to automate.

IGT: When Salary Cuts Are Not an Option

International Game Technology, a supplier of slot machines and other gaming devices based in Reno, Nevada, has been hit by double-digit health-benefit cost increases for its 4,000 employees. The message was clear, says Randy Kirner, vice president of human resources. “Either we make significant interventions to manage casts, or suffer cost increases outpacing our corporate revenue and earnings growth. Our dilemma on the employee side was equally compelling. We are an employee-oriented company and felt it was unfair to shift costs to employees to minimize corporate responsibilities. Cutting benefits was also distasteful.” Cutting salaries or wages was “absolutely not an option,” Kirner says. IGT is a growing company operating in one of the tightest labor markets in the country. Unemployment in Rena is a mere 3.2 percent.

Kirner turned to aggressive vendor management and new plan designs to control costs without cuts in wages or benefits or increased cost-sharing. “We engaged our broker, ABD Insurance and Financial Services, and other key stakeholders,” he says. The result was a top-to-bottom re-evaluation of administration and design based on a careful analysis of utilization and options. The firm consolidated two company health plans into one PPO, which enabled it to submit RFPs to third-party administrators. “We determined we wanted to look at vendors offering catastrophic and large-case management, disease management, maternity management, and electronic access for the company, providers, and employees,” Kirner says. The company chose a vendor on the basis of these needs and anticipates saving more than $1 million.

IGT also moved pharmacy management out of its PPO and into a separate company, which resulted in first-year savings of $300,000. In the process, the company identified an opportunity to change its delivery of specialty drugs, for additional savings of $25,000 a year. It also outsourced its COBRA/ HIPAA services, saving more than $25,000, and self-insured its vision plan. In conjunction with a new HRMS implementation, IGT tapped a data clearinghouse to improve benefit-billing accuracy.

IGT renegotiated its employee assistance program as well as short- and long-term disability and AD&D contracts for additional savings, and gained new features such as direct claim services and travel assistance. Finally, the company outsourced flexible spending account management, which increased service levels for employees while reducing internal costs. Kirner spent a great deal of time on the vendor and design overhaul. “The process was detailed and involved many, many sessions and decision points,” he says, “but the projected savings will ease cost pressures.” IGT carefully communicated the changes to employees. ‘Overall, employees were prepared for the changes and felt that the company had done its homework,” he says.

Random Cuts Can Endanger Performance

Jane Paradiso, practice leader for workforce planning at Watson Wyatt Worldwide, offers this cautionary message: “Before you begin cutting benefits, take a step back. HR executives tend to be reactive and often don’t have the metrics needed to look strategically at what is best for the organization.”

Cutting benefits without clear objectives and consideration of the impact on employees can undermine performance. Any changes in benefit plans should be part of workforce planning, which entails analyzing the demographics for employees and their dependents, identifying the most important positions, and calculating turnover and replacement costs. “With this information in hand, you can create an ROI model to determine which cuts make sense and what savings can be anticipated,” she says. “This is an unemotional analysis that looks at costs and the level of risk involved.”

Paradiso advises executives to look at the problem holistically and scientifically, and aim for a package of solutions–a combination of cutting some benefits and adding others–that is attuned to the needs of the organization, particularly in terms of retaining key people. “Otherwise, you’ll be left with a company of lower performers, and any cost savings derived from benefit cuts will be lost,” she says.

Effectively communicating the changes to employees is absolutely critical. “Make it honest, and make sure employees understand why the cuts are necessary.” She advises against asking employees for input on possible benefit cuts. “This approach frequently backfires,” Paradise says. “If you find that you cannot act on their recommendations, which is often the case, then you are in a difficult situation. It’s best for executives to make the decisions about cuts on the basis of business needs and objectives. This is their job and what they get paid for.”

Fay Hansen is a business and finance writer based in Cresskill, New Jersey To comment, e-mail editors@workforce.com.

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